A collection of impediments, from the US-China trade spat affecting European growth, to Brexit, populism and even the low levels of the River Rhine, have all conspired to keep European stocks undervalued compared to the US.
However, the outlook is much rosier than market participants believe, especially given recent positive consumer confidence data and the likelihood of fiscal stimulus, particularly in Europe’s largest economy of Germany, Cornelissen says.
“European equities have steadily cheapened vis-à-vis the US on a relative basis since 2009, and a reason often mentioned for this is that the political risks in Europe are relatively high,” Cornelissen says in the monthly outlook by Robeco Investment Solutions. “We think these risks are overstated and limited, despite all the rhetoric, and European equities are relatively attractive.”
“The European economy is an indirect casualty of the US-China trade war. Tariffs and threats have been a factor in slowing down the Chinese economy, and European exports – including German car exports – have suffered as a consequence.”
“One-off factors have also hampered German industrial production.The car industry has experienced difficulties in adjusting to the new more stringent EU emission standards, while the exceptionally low water levels in the Rhine have severely hampered the delivery of primary and intermediate industrial components, and led to restrictions on water intake for industrial companies. But these factors are expected to be only temporary; German auto shipments, for example, rebounded strongly in December.”
“In France, the populist movement is showing signs of weakening. French consumer confidence has been rising sharply since the turn of the year (see chart below), coinciding with a rise in the popularity of President Macron, who has humbly descended from the Élysée Palace and entered into a national dialogue in the provinces. The wave of ‘yellow vest’ protests appears to be ebbing.”
Meanwhile, a trade truce between the US and China – which had been threatening each other with tariffs on billions of dollars’ worth of goods – is now almost certain, Cornelissen believes. “The Chinese authorities, though bowing to reality by accepting a slightly lower growth target of 6.0-6.5%, will continue to step up monetary and fiscal stimulus,” he says.
“The most important factor leading to the truce, in our opinion, is the unfavorable equity market reaction to the ongoing tensions. That is why we think it is unlikely that the US president will heighten tensions with Europe, for example by imposing tariffs on European cars on national security grounds, even though he has recently hiked tariffs for India and Turkey by dropping their preferential trade status.”
And then there is the issue that has dominated recent headlines: the UK’s pained and still uncertain withdrawal from the European Union, due on 29 March. “At the time of writing, it is still unclear how and if the Brexit saga will end,” Cornelissen says.
“But the chances of a no-deal Brexit have come down markedly. The British parliament has forced the UK government to seek an extension of the 29 March leaving date if the withdrawal agreement with the EU fails to get a majority in the House of Commons. Basically, there are now two options: a delay (possibly followed by a new referendum, with polls suggesting a majority for remain) or parliamentary acceptance of the withdrawal agreement.”
“Ongoing Brexit uncertainty is starting to hamper the UK economy, but it should show resilience once it is clear that a hard Brexit will be avoided under any scenario.”
Europe’s other problem child has been Italy. “The truce between the European Commission and the populist Italian government on Italy’s deficit has led to a stabilization of the risk premium in Italian bonds vis-à-vis Germany. The truce is unlikey to hold now that the Italian economy has drifted into a technical recession.”
“But the Lega, currently the junior partner in the Italian cabinet, has strengthened enormously in the polls to the detriment of the anti-euro Five-Star-Movement. Given its deep roots in northern Italian businesses, the Lega is unlikely to adopt policies that would provoke an Italian debt crisis.”
“As it is expected to do well in the European elections, it could force new national elections after May to strengthen its hold on the cabinet. Markets have understandably shown signs of unease after the formation of the populist government, but now appear to have relaxed a bit.”
Finally, the world’s two major central banks, the US Federal Reserve and the European Central Bank (ECB), have been shifting towards a more dovish stance. A new two-year Targeted Longer-Term Refinancing Operation (TLTRO), partly enabling a rollover of the current one, was announced on 7 March. The ECB also changed its forward guidance, ruling out any rate hike this year.
“Some fiscal stimulus is also already in the pipeline for the German economy, to the extent of 0.3-0.4% of GDP,” says Cornelisson. “The likely successor to Chancellor Angela Merkel, Annegret Kramp-Karrenbauer, is playing with the idea of tax cuts in order to boost the German economy. Wage growth is also picking up as a consequence of the tight labor market, which bodes well for domestic consumption.”
“All in all, we think investors are too pessimistic about Europe. Although some issues have yet to be resolved, we reckon with a rebound of European economies in the second half of 2019.”
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